2010 Roth Conversion Rules
As you may already know,Congress passed a law in September that allows for in plan Roth conversions for 401(k) and 403(b) plans. The new rules allow for account holders to convert eligible funds into Roth (eligibility may vary between plans). Just because the conversion is allowed doesn’t mean that it’s right for you.
Pros and Cons of in-plan Roth Conversion:
The Good –
1. Regardless of income level, eligible account owners can convert to Roth. (Prior to 2010, you had to have an AGI (adjusted gross income) below $100,000 to convert.
2. If you think tax rates inthe future will increase, you might want to pay the taxes now.
3. You can spread the taxes over 2011 and 2012.
4. It is nice to have income options at retirement – portion of fund as pre-tax and Roth.
The Bad –
1. Your Tax liability may ACTUALLY be lower in the future. If your income in retirement is smaller, you’ll probably be in a lower tax bracket – making the conversion now a bad move.
2. You owe taxes now – If you convert in 2010, you can spread the tax bill over 2011 and 2012, but you’ll still need to come up with the taxes due.
3. If you think taxes will be lower in the future – Although unlikely, the tax bracket you’re in may lower – which means you would’ve paid less in taxes if you didn’t convert to Roth.
4. The 5-year rule still applies. In order for the earnings to be distributed tax free, the Roth funds have to be invested at least five years. Do you have five years to wait? If not, the conversion may not be right for you.
5. For Pastors – Don’t forget retirement housing allowance! Pastors are allowed to take distributions of ministry earned funds from their retirement account as a housing allowance (tax free). For ministers, this means that your pre-tax funds can come out tax-free as a housing allowance. Why would you want to pay taxes to turn your funds into Roth when you already get such a huge tax break!
Let go of the Roth hype.
As you think through these points, don’t let the hype of the Roth conversion sway your decision. You might be best off in retirement with no Roth funds at all. Or, you may only need to convert just a portion of your funds to Roth. The choice to convert your retirement funds into Roth is different for every person and should be discussed with your tax preparer or financial adviser.
If you’re eligible, are you planning on converting any funds in your 401(k) or 403(b) to Roth? What do you think about the new in plan Roth conversion rule?